Thursday, September 17, 2009

It is with some bemusement that I watch the various factions in Washington, Wall Street and, of course, the media expound on the issue of ‘the socialization’ of America. Radical pundits on the right warn of the dire consequences of President Obama’s ‘apocalyptic’ move toward the political equivalence of Hitler’s Third Reich or Stalin’s despotic communist regime. Rush Limbaugh in his infinite wisdom stated: "This is a full-fledged attack on capitalism, and the leftist Democrats have been seeking this for the longest time…"

On the other side of the debate, politically engaged documentary maker Michael Moore warns of the evils of capitalism while contradictorily lamenting over the free enterprise economy of the 1950s—contrasting it to the recent debacle instigated by the financial alchemists of Wall Street. Although Limbaugh and Moore (feels weird to type those names so close together) represent the fringe of the debate, the more moderate voices have made compelling arguments in defense of their respective positions with regard to the state of political economy in America. But perhaps both factions are mistaken: The warning of impending socialism at the hands of the Obama Administration or the call for socialism to save us all from the evils of capitalism is missing the point. Could it be, as many headlines suggest, that the America people are abandoning capitalism?—or—is capitalism abandoning ‘The People”?

% of Stock Market held by Institutional Investors

1950-2005

Direct Ownership of Stock held by American Households

1950-2005

Since the 1950s individual ownership of equity in American corporations has declined precipitously and has been replaced by institutional ownership—mostly comprised of pension funds and money management firms, including mutual funds. As a result of the institutionalization of participation in the free market economy individuals have forfeited their right to participate directly in the process of corporate governance. The result of this change in participation has placed the onus of accountability and responsibility on the fiduciaries that are entrusted to manage individuals’ savings. As has been referred to in the previous blogs, Adam Smith opined that “being the managers rather of other people's money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.” Circumstances on Wall Street attest to the validity of Smith’s insightful observation and have highlighted the conflicts of interest inherent in managed financial services. For instance, fees associated with managing money have been shown to have a significant detrimental effect on returns over both the short term and long term horizons, while being a tempting reward for accumulating vast amounts of money under administration. For example, $10000 earning a compounded rate of 8% for 25 years will become $68500, whereas, if you deduct a 1.5% annual management fee the result is $48300. Conflict of interest, which can lead to a violation of the expected level of loyalty in a fiduciary relationship, is difficult to avoid in the securities industry since conflict plays an integral role in the economic nature of the business. John Boatright in his recent book Ethics in Finance summarizes the ubiquitous conflict of interest dilemma:

“The inhabitants of Wall Street are motivated primarily by self-interest and can be induced to serve any master only within limits. The challenge, therefore, is not to prevent conflicts of interest in financial services but to manage them in a workable financial system” (Boatright 2008: 51).

Another problem of entrusting ones savings to a management firm stems from the fact that there has been increasing pressure on money managers to focus on investment strategies that concentrate short-term returns in equity markets, rather than traditional long-term investing based on durable intrinsic corporate value. In a 2005 WSJ article John C. Bogle points out that from 1950 to 1965, equity mutual funds turned over their portfolios at an average rate of 17% per year; in 1990-2005, the turnover rate averaged 91% per year. In earlier decades ‘Joe Public’ would take pride in having his shares of GM, IBM, General Electric etc. in a safety deposit box at his local bank or in safekeeping at the regional brokerage house. Today, Joe Public’s savings are abstract holdings being managed by ‘experts’ in a distant locale. The individual’s intimate connection with American free enterprise has vanished into the annals of investment history. It seems that Wall Street has replaced investing in America's future with speculating on America's credit.

A relatively recent development threatening the conventional concept of capitalism is the advent of Sovereign Wealth Funds. (SWF) SWFs are becoming a major force in international capital markets and will become increasingly important as globalization becomes an entrenched reality affecting both the culture and economy of many nations. Tremendous international wealth transfers, as exhibited by the recent global econometrics, portend further pressures being placed upon the structure of corporate ownership. This in combination with the foreign exchange reserves being held by countries such as China ($2132 billion) will continue to diminish the levels of direct domestic participation of the individual in the free market system

The cover story of Business Week in September 2000, during the boom times before the dot.com bust, indicated that Americans think business has gained too much power over too many aspects of their lives. Deregulation, globalization and corporate consolidation have contributed to the concerns expressed by individuals. It can be safely assumed that in light of the 2008 financial meltdown, individuals’ trepidation toward corporate control of their lives has only increased. Further aggravating the diminution of individual participation in the economy is the increased predominance of corporate lobbyists who have influenced politicians to the extent that government legislation often equates to de facto corporate policy, superseding policies directed towards the enhanced well-being of the individual.

The concept of free market capitalism envisioned by Adam Smith in An Inquiry into the Nature and Causes of the Wealth of Nations was intended to enhance the lives of individuals by facilitating the pursuit of ones own self interest, encouraging innovation through the division of labour and distributing wealth through freedom of trade. Smith did not intend that globalized corporate conglomerates were the ‘shopkeepers’ when he stated that: "To found a great empire for the sole purpose of raising up a people of customers, may at first sight, appear a project fit only for a nation of shopkeepers. It is, however, a project altogether unfit for a nation of shopkeepers, but extremely fit for a nation whose government is influenced by shopkeepers." Smith would have contested the contemporary capitalist paradigm due to the concentration of economic power and the diminished role of the individual in the distribution of the wealth gernerated by free markets. He certainly would not have considered a corporate plutocracy as being the equivalent of a shopkeeper. Smith would likely concur with Noam Chomsky's view on who are the antagonists of individual liberty:

"An array of mega-corporations, often linked to one another by strategic alliances, administering a global economy which is in fact a kind of a corporate mercantilismtending toward oligopoly in most sectors, heavily reliant on state power to socialize risk and cost and to subdue recalcitrant elements."

Libertarians are ideologically committed to the belief that individual liberty is both the intrinsic and normative primary concern of a free society. It is bewildering to see the right wing of the American political spectrum, who claim to embrace the principles of liberal individualism, condone the Darwinian transformation of a system of free market capitalism—intended by Adam Smith to distribute wealth amongst hard working innovative individuals—into an economic system that marginalizes and alienates the individual from the economic process.. The American people have not abandoned capitalism: Capitalism has abandoned the American people—abetted by the politicians they elected to represent their collective and individual interests.

1 comment:

I believe the reason that democracies descend from free markets to something that more resembles Mussolini's corporatism is the inherent laziness of politicians. Having economic power concentrated in a handful of players ensures that the rolodex never gets to big, and the shakedown for money and favors is made with a minimal number of phone calls.

Having an open market with hundreds if not thousands of players makes it difficult to cultivate rent seekers. Can't have that.